Knowledge in Development Note: Aid & Millennium Development Goals

The Millennium Development Goals set forth quantified targets for reducing poverty, and improving health, education and other development objectives by 2015. The key goal of reducing by half the proportion of people living on less than a dollar a day is expected to be met worldwide, except in Africa, where none of the targets are expected to be achieved. Progress could be accelerated by scaling up aid levels, and improving the ability of developing country governments to use resources effectively.

Continued support for increased aid by taxpayers and parliaments in donor countries depends on demonstrating sustained positive impacts on development in recipient countries. Ineffective aid programs risk undermining support for the aid increases envisioned in the 2002 Monterrey Consensus which called for developed countries to devote 0.7 percent of their GNP to official development assistance (ODA).

Research can inform donor agencies on the effectiveness of alternative approaches to aid. Is aid more effective in certain policy and institutional environments? Is aid more effective at achieving the MDGs when targeted to certain sectors? Is aid fungible across sectors? How can donors design and implement more successful projects? Should more aid be provided in the form of budget support instead of project aid or technical assistance? Do successful donor-funded projects aggregate to a successful program? Should aid be redirected toward scaling up proven interventions, and away from interventions that have not been subject to rigorous impact evaluation?

What we know

The large empirical literature on aid and growth has not produced a consensus

Common sense suggests that aid effectiveness must depend on the quality of the recipient country’s policy and institutional environment. In extreme cases, aid may be diverted to overseas bank accounts or used to fund violent conflict. But earlier cross-country findings[1]—that aid contributes to growth only in a favorable policy environment —are not robust to changes in specification or methodology, or to using an updated and expanded dataset.[2]

Several cross-country studies find aid contributes to growth but with diminishing returns. Other studies find aid is good for growth but only in recipients located farther away from the tropics. Yet others find that aid from certain donors (multilaterals and/or Nordic countries) or of certain types (e.g., excluding humanitarian and other aid with non-growth objectives) is good for growth.[3] All of these results have been questioned and none of them are generally accepted.[4]

Cross-country data on aid, policies, and growth may be too noisy for growth regressions to produce any robust findings, particularly for the many hypotheses testing interaction terms using a limited number of aid recipients.

Aid targeted to priority sectors or regions will partially “leak” to other uses

It is difficult for donors to ensure that aid earmarked for favored sectors, such as health and education, is fully additional, even if aid is provided mostly for projects. In general, when a donor earmarks aid for a particular sector, it is at least partially fungible: some aid “sticks” to the targeted sector, but part of it passes through to other sectors, or allows reductions in tax revenues.[5] One study estimates that for each $1 of aid military spending rises by 11 cents.[6]

There is some evidence that aid for infrastructure investments is less fungible than other types of aid.[7] A study of health projects in Vietnam found no evidence aid leaked to other sectors, but strong evidence of fungibility across provinces as government re-directed expenditure toward areas not targeted by the aid projects.[8]

Aid generally is an ineffective tool for encouraging market-liberalizing policy reformMost empirical studies have concluded that there is no relationship between aid and policy reform, for adjustment loans in particular and for aid in general.[9] One study even finds that policy reform in the 1980s was faster where aid volumes were lower (correcting for reverse causation and controlling for other factors).[10]

Conditionality appears to be effective only in the early stages of reform, when it can bolster the position of reform advocates in government.[11]

The World Bank use of conditions has fallen sharply since the late 1980s, and the content of conditionality has shifted from short-term economic adjustments to institutional reforms in social sectors and in public sector governance.[12]

Aid can have unintended adverse effects on accountability and capability of governments

Revenues from natural resources are sometimes termed a “curse” as some studies find they increase the risk of conflict, make democratization less likely, or fuel government corruption. Aid is another source of windfall revenues or “sovereign rents” with potentially similar drawbacks, but aid unlike oil is accompanied by donor conditions or technical assistance that can reduce its negative side effects.[13]

Countries receiving more aid (correcting for possible reverse causation) tend to experience increases in corruption, and deterioration in bureaucratic quality, the rule of law,[14] and quality of tax policy and administration.[15]

Industries more dependent on strong public sector institutions—as proxied by levels of intermediate-goods purchases from other industries—grow more slowly in countries with higher aid inflows.[16]

There is some evidence that aid’s negative impact on the quality of governance tends to be greater where aid is “fragmented” among a larger number of donors.[17]

Project success is determined by country performance, but also by donor performance

World Bank projects are typically more successful in countries with better policies and institutions.[18]

World Bank aid, particularly IDA aid, has become better targeted toward countries with more favorable policy and institutional environments.[19]

Donor-controlled variables have no impact on the success of World Bank adjustment programs,[20] but can affect the performance of World Bank projects.

More resources devoted to country analytic work,[21] and to project supervision,[22] have a positive impact on the performance of World Bank projects.

The quality of the project, as designed by the donor, is the most important determinant of project success, but it is tied to recipient country characteristics: good policy environments tend to receive good projects, while bad environments tend to receive bad projects.[23]

Ongoing research inquiries

What determines aid levels in donor countries?

Ongoing research in the research group analyzes the effect of past financial crises on donor countries’ aid levels. Preliminary results indicate that effects are deep and long-lasting. Aid volumes are independently affected by per capita income levels in donor countries, so the current global recession could reduce aid even in donors not experiencing a financial crisis.[24]

Cross-country opinion surveys can be exploited to better understand the constraints placed on bilateral donor agencies by their domestic constituents. An analysis of opinion surveys finds that support for aid is weaker among respondents who are insecure about their own personal finances, suggesting that the financial crisis in donor countries may weaken support for aid. Support for aid is also higher for people who are more interested in politics, left-of-center, religious, have more trust in their governments and in international organizations, and who live in donor countries that are smaller or have more former colonies.[25]

How can aid be made more predictable at the country level?

Aid commitments by donors are a poor predictor of actual aid disbursements. Aid levels tend to be more volatile than fiscal revenues; moreover shortfalls in aid and in fiscal revenues tend to coincide.[26]

There is some evidence that aid volatility has worsened in recent years. This trend may be due partly to the trend toward budget support and away from project aid, and increased reliance on performance-based aid allocation systems.

A Bank study[27] provides recommendations for reducing aid unpredictability. Simple spending and savings rules built around a buffer reserve fund of 2-4 months of imports can help smooth public spending. Aid can be pre-committed several years ahead with only small efficiency losses resulting from misallocation to poor performers, using a strategy of “flexible pre-commitment.” Guidelines can be set to limit the volatility of budget support while keeping it performance-based.

When do donors rely on recipient country systems for managing aid?

The Paris Declaration sets numerical targets for increased use of country systems. An individual donor bears the full risk of using weak country systems, but shares the institution-building benefits with all other donors, so use of country systems is likely to be below the developmentally optimal level. Ongoing research finds that donors’ use of country systems is greater where the quality of those systems is higher, and where it has a larger share of the aid “market,” i.e., where it internalizes more of the benefits.

Multilateral agencies use country systems more than bilateral, and among the bilaterals, use of country systems (i.e., tolerance for risk) is greater for donors with more popular support for aid in opinion polls.[28]

Future research directions

Is aid targeted toward countries where its impact is likely to be greatest?

Most “governance” indicators used in cross-country research are intended to measure human rights, political freedoms, or risks confronting multi-national investors. New indicators of the quality of public financial management (PFM) systems are becoming available, with more direct relevance to the productivity of aid and other public funds. Future research can investigate how quality of PFM systems affects aid allocations, and whether the impact of aid on development outcomes depends on quality of PFM systems.

If aid is fungible across donors, any effects of targeting by the IDA, Millennium Challenge Corporation, or similar performance-based allocation systems can potentially be nullified by other donors. As additional data on aid from China and other emerging donors improves, researchers can assess their impact on overall aid selectivity by policy performance, poverty, and country size.

Would aid be more effective if Paris Declaration targets were met?

The Paris Declaration (2005) sets numerical targets on donors’ use of country systems, coordination with other donors on missions and analytic work, and aid management practices associated with “harmonization” and “alignment.” Many of the goals reflect untested assumptions, and research could usefully provide some guidance on their importance for improving aid effectiveness.

The trend toward greater budget support at the expense of project aid suggests a need for more research on the desirability of one versus the other, in different environments (such as strong or weak public expenditure management systems).

The Paris Declaration indicators purport to measure aid quality. Future research can investigate the validity of efforts to rank donor performance using these and other indicators (e.g., including aid selectivity).

Harmonizing and aligning aid implies yielding control over how it is implemented, so a donor’s funds are less likely to produce visible outputs that can be attributed directly to its efforts. Research could address the issue of possible tradeoffs between Monterrey Declaration and Paris Declaration goals: in donor countries where support for aid is already relatively weak, making it less visible could undermine political support for maintaining or increasing aid volumes.

How can impact evaluation best be used to guide aid decisions?

Although some have argued that “development” is an over-ambitious goal for aid given the limited knowledge we have on how to accomplish it,[29] the Bank has made significant progress in learning what works, what doesn’t and why. Impact evaluation has been developed in numerous Bank projects and is building the evidence base for how to make aid more effective.

Despite its importance, however, demonstrating that particular interventions are associated with improved outcomes is only part of the story in deciding how far to scale them up. Generalizing findings is often problematic.[30] Aid may support projects that the government would have financed anyway; donors may “cherry pick” those with the highest chance of success. And because resources are fungible, aid may in fact be allowing the government to finance unproductive investments. In such cases, establishing a counterfactual is difficult.

Projects may have spillover effects that are difficult to measure. When it supports projects that show better ways of attaining outcomes, aid has a valuable demonstration effect, and a narrowly defined “impact evaluation” would miss this effect. Spillover effects can also be negative: for example, project success may be enhanced by hiring high-quality administrators away from government jobs where social returns to their labor are higher. Attempting to identify and measure these spillovers is an important but difficult area for research.[31]

Aid funds should not necessarily be reallocated from interventions that have not been (or cannot be) rigorously evaluated to scale up interventions demonstrated to succeed. The potential payoff contingent on success must be considered, as well as the likelihood of success. Some types of interventions—for example, reforming the budgeting processes of central governments—cannot be subject to randomized experimentation, but their potential payoffs may be extraordinarily high. Designing more rigorous evaluations of these interventions, where randomization is impractical and the degrees of freedom for analysis are limited, is an important research challenge.

For a specific example from Vietnam, see D. van de Walle and R. Mu. 2007. “Fungibility and the Flypaper Effect of Project Aid: Micro-Evidence for Vietnam.” Journal of Development Economics 84(2): 667–85.